A comprehensive overview of Civil Law Foundations

Civil Law Foundations are something that we don’t have in the UK within our legal framework. They originate from civil law tradition from countries in Central Europe, classically Liechtenstein, Austria and Germany.

Most commonly in practice you tend to see them in Liechtenstein, but a number of jurisdictions offer them. Panama has offered them for a number of decades. Some common law overseas jurisdictions have created a statute to offer them, for instance, Jersey, Guernsey, Nevis and St Kitts, and probably more over time.

They’re something that’s alien to the UK which raises some quite interesting questions in terms of how to treat them for UK tax purposes, because not only are they historically alien, but we don’t have any statute which explicitly accommodates them either.

Their most common purpose is for holding, preserving, protecting family wealth. So, very similar to the purpose that a lot of people in the UK have set up trusts, and that’s a key thing. Actually, we’ve evolved trusts to serve much the same purpose as some other jurisdictions have evolved foundations instead.

I don’t think the UK actually has a need for them as such, because we have our own distinct history and our own distinct ways of creating arrangements to serve the same sorts of purpose. Commonly foundations in civil law jurisdictions have been set up for family wealth protection and preservation purposes. Here in the UK we have our own history of trusts going back nearly a thousand years now.

We also have companies, albeit civil law jurisdictions have companies too, sometimes foundations are set up for commercial purposes. In the UK you wouldn’t ordinarily set up a trust and think of it operating commercially, although sometimes you do get quite significant commercial operations within a trust, it’s always for the benefit of the class of beneficiaries.

But foundations, they have a board or a council, a little bit like the board of a company, you could argue, but also like trustees in practice. Where they’re set up for family wealth purposes they don’t generally issue shares, although on some occasions they sometimes have a list of named beneficiaries. The way a discretionary trust or an IIP trust might have, say, in the UK by the board or the council can vary enormously, to the point sometimes where actually you can argue that maybe there’s no discretion there at all, sometimes the opposite, sometimes there are no named beneficiaries, but they have what’s called founder’s rights. Where it’s created by a person, they have complete rights, albeit they can transfer those rights at some point to somebody else.

So they vary enormously, even in a jurisdiction like Liechtenstein they can vary a great deal in terms of how their constructed, the legal documentation and how they’re operated in practice. But they are all legal entities in their home jurisdiction and they do all exist on an official register the way a company would.

Because we don’t actually formally recognise foundations in the UK, we have our own legal framework. It’s pretty established practice in the UK that it’s a question of trying to determine what a foundation, any given foundation, on its own facts most closely determined. So it’s a question of looking at all of the hallmarks and finding the best approximation to a UK equivalent.

In fact, always in my own experience of looking at scores and scores of foundations, of dealing with HMRC over the years, they turn out to be some sort of a trust. But even then it’s a question of what sort of trust. In some circumstances they could be akin to a discretionary trust or it could be akin to an interest in possession trust.

In some circumstances quite commonly, actually historically, a lot of them were more closely akin to a bare trust, in which circumstance there’s a fiduciary arrangement, but the board are only really held for UK tax purposes. To be holding the legal title of assets which are actually absolutely beneficially owned by other parties, whether that’s the founder or someone else.

This is interesting because HMRC used to state that their default position was that foundations should be treated as Companies, and it was even in their guidance many years ago. But I never in practice, going back 25 years,  have experienced a situation where HMRC ultimately agreed that a foundation was a company.

There’s always a first time and it was interesting as well when HMRC entered into an agreement with Liechtenstein a number of years ago to regularise the tax affairs of UK residents with interests in Liechtenstein, including Liechtenstein foundations, that the treaty actually specifically stated that in ordinary circumstances, most Liechtenstein foundations would be treated as trusts in recognition in the stated logic for that they represented a fiduciary arrangement for holding family wealth.

We’ve grown up in parallel and because we’ve never had any, we’ve had a different legal framework and we’ve never had any recognition of foundations. It’s one of those things. Nobody in the UK would create a foundation with the attendant uncertainty that it involves when we have other alternatives, normally trusts, and because it’s gone on like that, it hasn’t been a problem that’s needed statute to solve it and actually, in my view, the sort of pragmatic approach of finding an appropriate UK equivalent to any given foundation based on its own facts and circumstances works very well.

There’s a notable absence of case law in the tax courts where HMRC and taxpayers have litigated over it, which suggests to me that historically, both sides have been able to find a fair accommodation which is a fair representation of reality for their particular situation.

There are several. It depends on the circumstances. HMRC have a fairly well-established disclosure portal now for making worldwide disclosures. They call that the Worldwide Disclosure Facility and the way that works is you register, you make an application to make a disclosure and then they process the application, they write back. They give you 90 days then to submit an electronic form with basic details and then in practice an advisor like me will always submit a report alongside that, actually explaining where the numbers come from, in order to prevent HMRC then – you hope – investigating into the disclosure.

There’s inherent uncertainty with any foundation where the UK is concerned. So it’s very important to get professional advice from somebody familiar with dealing with foundations and with HMRC on what the most likely characterisation is. But even then they can’t provide absolute certainty. So it’s going to be a question of broaching it with HMRC within the context of a voluntary disclosure if this is an existing historic arrangement that’s been running for a period of time. So there’s the worldwide disclosure, which is HMRC’s normal preferred route for offshore-related disclosures.

That works quite well for relatively straightforward disclosures for comparatively modest amounts of tax. It doesn’t necessarily lend itself if there are very, very large arguments of tax at stake and things are very complex. What I do quite often that sort of situation is I’d contact HMRC and ask to make a disclosure under something called Code Of Practice 8 , which is for large, complex matters where there’s no serious evasion suspected but there are possible tax avoidance issues, and application of tax avoidance legislation to take into account. So in those circumstances where the amounts merit it, you can approach HMRC to have a dialogue with a team of experienced inspectors used to dealing with those sorts of big, complicated situations in a pragmatic sort of purposive way.

The UK’s anti-avoidance legislation generally, including transfer of assets abroad, impacts on people with connections to foundations, potentially just like it could impact on them if they had had interests in any sort of conventional sort of offshore structure..

Of course, the reason for that is that, depending on whether you characterise the the foundation as being, say, a discretionary trust, interest in possession trust, or a company, then the UK tax consequences flow from that. So all of our legislation that might impact on offshore trusts, will impact on a foundation if it’s characterised as an offshore trust. Similarly, any legislation that impacts with regard to an offshore company, would impact if a foundation is treated as an offshore company.

I mean, like I said before, in practice it’s very, very rare that you would say that a foundation is most closely akin to a company, notwithstanding some superficial hallmarks that the reality tends to be that most foundations are set up and operated like trusts. But in a situation where the correct characterisation of a foundation might be that it was most akin to a company, then yes, you’d be looking at the application of ATED rules (Annual Tax on Enveloped Dwellings). If the foundation held residential property in the UK, it would be treated as an envelope under the ATED rules.

Very rarely with foundations. The thing with foundations is there’s so much inherent uncertainty about how they’re treated that it tends to be more, and very often people accidentally fall into a situation with a foundation in the UK because they set one up before they come to the UK or they acquire an interest from somebody overseas. So it’s rare that fraud is involved, but occasionally there could be. Occasionally the foundation could have been used to try and conceal overseas wealth and income and gains may not have been disclosed to HMRC.

In those circumstances, if there is actually some sort of tax evasion to admit to and the taxpayer would have to admit to it up front, then there’s something called Code of Practice 9 at the contractual disclosure facility where a taxpayer can actually approach HMRC to make a voluntary disclosure and, subject to being accepted into the facility and full cooperation and making a full disclosure, there’s a guarantee of non-prosecution. So that’s applicable in some circumstances but that tends to be quite unusual where foundations are concerned.

The WDF is a pretty well-oiled machine in terms of the way HMRC operates it, monitors it, and the details of how to make the disclosure. You need reference payment references, that sort of thing. You then get three months to go away and prepare a disclosure, which will require a digital form. But also in these sorts of situations, an advisor like me will always prepare a report to go in alongside explaining where the numbers come from. Otherwise, HMRC would have to investigate into the numbers, which isn’t what you want.

If the numbers are very large and the issues are quite complicated, you haven’t really got much control of the WDF over which sort of HMRC officer will necessarily deal with it and how pragmatic they might be, the extent to which they have to use external HMRC resource, or even actually whether they might just hand it over anyway to a COP8 team. So if it’s large and it’s complicated, and there’s enough money at stake. In those circumstances, I tend to favour a Code of Practice 8, just to be able to have a pretty high degree of certainty about going to an HMRC team used to dealing with large, complicated and sometimes uncertain situations in a pragmatic, sensible way.

I think the biggest historic misconception, although it’s going away now, is that HMRC’s default position is going to be to want to treat foundations as Companies.

That was never really the case in practice and given the number of foundations that HMRC have been dealing with in recent years through the Lichtenstein Disclosure, then from the framework that’s drawn up for that it’s pretty clear now that most foundations tend to be best characterised as some sort of a trust.

Another misconception on the part of the taxpayers is that they can just ignore the problem forever and HMRC will never become aware. It’s quite an uncomfortable situation for a lot of taxpayers because they’ve got this thing called a foundation or some sort of interest in it. They know it doesn’t sit very well with UK tax, they know there’s uncertainty but they don’t know how to go about broaching it. So it’s quite easy just to keep kicking the can down the road. But all the time that that’s happening, there’s very often more and more income being generated within the foundation and gains. They tend to be drawing funds out and whatever the appropriate tax characterisation might turn out to be.

All of those tax consequences are just rolling along and another year’s being added all the time and, depending on the circumstances, HMRC can go back quite a long time to assess tax. So it can be in situations where no tax returns were filed at all, a situation called failure to notify, where taxpayers might have had some sort of a liability and didn’t notify HMRC of their accessibility to income, and maybe they haven’t filed any self-assessment returns at all of those years.

Then in that sort of situation HMRC can go back up to 20 years in the absence of a reasonable excuse, which isn’t commonly known, but obviously is quite scary. Even where tax returns have been filed, there’s legislation that came in a few years ago which means that HMRC are going to be able to go back up to 12 years to assess income and gains, even in situations where any errors were innocent rather even than careless. The old-fashioned rules, the traditional rules, were four years for innocent error on tax return, six years for careless, up to 20 years for deliberate.

HMRC have got quite a long time to become aware of something and then set about recovering any tax, and they have so much more information now at one time, I think, a lot of people were quite confident that HMRC would never become aware of a foundation, and sometimes interest in foundations were passed down from one generation to another and HMRC was none the wiser, whereas now there’s so much exchange of information around the world between tax authorities and also there’ve been so many data leaks from offshore service providers that HMRC has a huge amount of information that it didn’t otherwise have.

I would always say to taxpayers you know, you’ve got to grasp the nettle, you do need to take advice. And then it’s a question of mitigating the position and actually by going to HMRC voluntarily, it puts you in a very strong position to put your best foot forward as credibly as you can for the characterisation of the foundation which you might think is most fair and appropriate, and heavily mitigate any possible penalties

We have a large tax team, who are very experienced at helping international families with their tax affairs generally, with their compliance planning and also rectifying any situations that might come to light. We can help people with not just foundations like this, but with trusts and the whole gamut of professional services for private clients.